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Distortionary Taxation, Rule of Thumb Consumers and the Effect of Fiscal Reforms

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  • Andrea Colciago

    ()
    (Department of Economics, University of Milan-Bicocca)

Abstract

We consider a standard growth model augmented with a share of rule of thumb con- sumers. A Government ?nances a preset level of public expenditure through ?at tax rates on labor and capital income and also makes lump sum transfers to non ricardian consumers. It has been shown in representative agents models with perfect competition that balanced budget rules with endogenous tax rates are likely to generate indetermi- nacy of the perfect foresight equilibrium. We show that the presence of rule of thumb consumers reduces this possibility. Further, we show that a ?scal reform which features a reduction in the capital income tax rate and leads to the steady state where the welfare of non ricardian agents is maximized could be Pareto improving. This is obtained via a direct redistribution of resources to rule of thumb consumers along the transition path.

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File URL: http://dipeco.economia.unimib.it/repec/pdf/mibwpaper113.pdf
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Bibliographic Info

Paper provided by University of Milano-Bicocca, Department of Economics in its series Working Papers with number 113.

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Length: 25 pages
Date of creation: 2007
Date of revision: 2007
Handle: RePEc:mib:wpaper:113

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Keywords: Non Ricardian Agents; Fiscal Policy; Capital Income Tax Rate;

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  1. Teresa Garcia-Milà & Albert Marcet & Eva Ventura, 1995. "Supply side interventions and redistribution," Economics Working Papers 115, Department of Economics and Business, Universitat Pompeu Fabra.
  2. Jordi Gali & J. David Lopez-Salido & Javier Valles, 2004. "Rule-of-Thumb Consumers and the Design of Interest Rate Rules," NBER Working Papers 10392, National Bureau of Economic Research, Inc.
  3. Benigno, Pierpaolo & Woodford, Michael, 2006. "Optimal taxation in an RBC model: A linear-quadratic approach," Journal of Economic Dynamics and Control, Elsevier, vol. 30(9-10), pages 1445-1489.
  4. Judd, Kenneth L., 1985. "Redistributive taxation in a simple perfect foresight model," Journal of Public Economics, Elsevier, vol. 28(1), pages 59-83, October.
  5. Klein Paul & Quadrini Vincenzo & Rios-Rull Jose-Victor, 2005. "Optimal Time-Consistent Taxation with International Mobility Of Capital," The B.E. Journal of Macroeconomics, De Gruyter, vol. 5(1), pages 1-36, June.
  6. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May.
  7. Kevin J. Lansing, 1998. "Optimal redistributive capital taxation in a neoclassical growth model," Working Papers in Applied Economic Theory 99-01, Federal Reserve Bank of San Francisco.
  8. David Domeij & Jonathan Heathcote, 2004. "On The Distributional Effects Of Reducing Capital Taxes," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 45(2), pages 523-554, 05.
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Cited by:
  1. Albonico, Alice, 2010. "Policy Games with Liquidity Constrained Consumers," MPRA Paper 25666, University Library of Munich, Germany.

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